Connecting DeFi to Real World Credit: The Sentiment Thesis

Nick Gardner
6 min readMay 25, 2022


In order to see where we are going, we must first see where we came from. The introduction of money markets in the 1900’s presented a novel way for retail savers to earn yield by lending money to borrowers who would allocate that capital to its highest and most productive use. At the institutional level, these markets allowed banks and investment funds to take on more leverage and effectively underwrite and price risk for investors. Today, these markets represent the building blocks of a functional financial system characterized by a high degree of safety and a relatively low rate of return.

Over the past 100 years, financial markets have changed drastically, mostly in terms of speed (100 times faster), but the constructions through which capital flows have been remarkably unchanged.

The purpose of a sophisticated financial system has always been to find the most efficient way to raise and use capital across an economy. Yet despite forming some of the most robust components of the modern financial system, traditional credit/money markets have become capital-inefficient by virtue of costs to operate, and the massive amount of value extracted by intermediaries.

Decentralized Finance

DeFi changes everything.

It doesn’t just re-invent finance or the fintech stack, it actually makes them better. The underlying software of DeFi (AMMs, DEXs, liquidity pools, noncustodial wallets, etc.) reduces the involvement of intermediaries; in many cases, it removes them entirely. DeFi protocols (if built properly) are much more capital-efficient by design. These protocols will always generate higher yields for three reasons.

1. They can tap into global pools of liquidity.

2. The software they run on collapses the cost to operate (virtually no overhead).

3. They can compose to leverage features of each other and stack yield.

For these reasons, lending and borrowing platforms have found some of the greatest product-market fit as it relates to the broader crypto ecosystem.

Over-Collateralized Lending and Borrowing

Over the past 24 months, over-collateralized lending and borrowing has dominated DeFi in terms of volume and TVL. Projects such as Compound, Maker, and Aave have pushed the thought boundaries of what an on-chain financial system could look like and pondered questions around what new technology and infrastructure would need to be built to on-board the first billion users into the world of decentralized finance.

The underlying problem with the current class of DeFi lending platforms is that they have to be over-collateralized because there is no way to effectively mitigate credit risk . When borrowers are forced to over-collateralize their assets the demand for lending becomes so much greater than borrowing (with roughly eight lenders for each borrower). This means that the only way for these protocols to achieve high yields is through inflationary rewards.

This is not a sustainable model (Anchor is a prime example) and will never scale to support a billion users because the yields just naturally fall over time.

The cost of capital in these systems is relatively cheap compared to incumbent finance, but what you can do with these protocols is very limited. This is because they lack composability and the infrastructure to support under-collateralized debt and credit markets.

Under-Collateralized Lending and Borrowing

If users are going to continue to chase yields (market forces will push them to), then the industry must follow the former credit markets and find new and innovative ways to tap into giant pools of capital.

As of this writing, Dai, Tether, Celsius, and Blockfi have mountains of capital they have to lend out, and everyone in crypto is sitting on mountains of coins they want to yield-farm. That’s great, but the problem is that no one wants to borrow those assets because the collateralization ratios are too high.

In traditional credit markets, people borrow (fiat) for working capital so that they can buy a house, build a business, hire people, and pay expenses. This is under-collateralized borrowing and lending, and its market size is an order of magnitude larger than what the current class of DeFi lending protocols touch.

Compound, Aave, and Maker are robust and essential building blocks of this new financial system, but what comes next is Sentiment.


At its core, Sentiment is a decentralized credit protocol that expressly facilitates under-collateralized lending and borrowing. The focal point of Sentiment is to build the infrastructure layer that enables the capital efficiency of DeFi to plug into real world credit and lending markets.

For a robust on-chain credit market to exist, the infrastructure for mitigating credit risk with minimal counter-parties must exist.

Let’s start with the former, which I would argue is the biggest pain point in DeFi right now. Remember, you can only reduce credit risk, not eliminate it. Sentiment tackles this problem in two ways:

  1. Hypothecating assets on-chain while maintaining a percentage of the borrower’s collateral in case their account falls below a certain threshold.
  2. Through delegated ownership, this model allows control of how the funds are deployed without having custody of the loaned assets, thus pushing the first right of ownership to the protocol.

In this case, the borrower is effectively underwriting their own risk.

As for the latter, Sentiment enables users to take on credit risk with the introduction of their margin “Account” primitive. This is a product that is similar to a traditional margin account, but it is much more than that. One of the greatest features of these accounts is that leverage is built into the product itself (assuming users want good capital efficiency). This takes the guard rails off of leverage and allows users to deploy it anywhere in DeFi. As a result, users have the flexibility to create complex and high yield generating structured products that simply cant exist in traditional finance.


The relationship between lenders and the protocol is interdependent. In other words, a user will open an account, create a strategy/structured product, and any lender providing liquidity can invest in that strategy. As an LP, you’re not just gaining fees or accruing interest by lending assets, you’re investing in the strategy itself. This enhances the value proposition for lenders (higher yield) and ultimately drives demand for deeper liquidity.


The cost of capital in Sentiment will be higher than in over-collateralized protocols, but it’s the trade-off borrowers make for greater capital efficiency. A lot of the initial use cases will come from borrowers using the platform to leverage long-tail assets. These are assets in the crypto market that are liquid but not accessible with leverage on any centralized exchanges. Sentiment is not just for users who want to take degen trades, it is also for sophisticated money managers and institutions with high volumes that want a little more edge on their assets.


What separates Sentiment from Maple, Goldfinch, Gearbox, and other credit systems is just how much they have thought about optimization in terms of capital efficiency. Current lending protocols force users to deposit collateral in single isolated positions. If most crypto users are sitting on mountains of tokens, why would they want to borrow against only one asset when they have a bunch? With a Sentiment account, users can cross-margin and borrow against multiple assets that may already be earning interest. By utilizing this feature, anything that has a token and can be priced essentially has value in the market.


All financial innovation can be boiled down to figuring out new ways to take on more leverage, and de-risk. The idea of building a decentralized credit infrastructure where productivity is matched by capital in the most efficient way is extraordinarily disruptive. True credit creation in DeFi will allow retail and institutions to be able to borrow under-collateralized, so that they can continue to grow their businesses and wealth. Eventually, the project that creates a robust on-chain credit system with greater capital efficiency than traditional money markets will build the guardrails for mainstream DeFi adoption. I contend that project is Sentiment.